Transfer Pricing, DR-CAFTA & Free Trade in Central America

21 June 2016
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Taxlinked (TL): What are some of the trending issues in transfer pricing being experienced by Central American nations?

Ximena Tercero (XT): In most of the Central American jurisdictions, transfer pricing regulations are relatively new. In Guatemala, for example, taxpayers with commercial operations with a foreign-related entity were requested on 2014, 2015 and 2016 to file an annex to their annual income tax return and in Honduras the same obligation applied for taxpayers on December 2015.

In that order, one of the main challenges for both, taxpayers and tax authorities, is adapting to the new compliance requirements and, in the case of tax authorities, engaging in proper auditing processes. Nicaragua has its regulation published but it will not come into force until 2017. Both taxpayers and tax authorities are preparing to properly face this new stage.

There are some other challenges that all Central American jurisdictions are facing, such as the increase of costs related to transfer pricing studies and the use and licenses of trademarks, as well as the implantation of back office, management and direction services.

As for Guatemala, transfer pricing rules apply to operations that have an effect on the taxable basis and as such is directly linked to profitable activities. In that order, operations between related parties that imply a capital gain should be left outside the scope of transfer pricing rules; nevertheless, the Guatemalan Tax Administration Office does not share such criterion. Since there are no legal precedents yet in that respect, some taxpayers prefer to apply transfer pricing rules for some operations that imply a capital gain rather than an income derived from a profitable activity.

TL: What was your role in the first advance rulings under the Free Trade Agreement between Central America and the US? How will this decision help local Central American industries?

XT: Arias & Muñoz’s Guatemala, Costa Rica and El Salvador offices have helped a plastic manufacturer obtain advance rulings of origin ensuring that the products produced in Salvadorian free trade zones will retain special tax treatment in Costa Rica and Guatemala in line with the Dominican Republic-Central American Free Trade Agreement (DR-CAFTA).

As a Guatemalan lawyer, I was in charge of guaranteeing the client that DR-CAFTA benefits applied to their import operations would not be challenged by the Tax Administration Office or by the Ministry of Economy. Following the procedures established in Guatemalan customs laws, DR-CAFTA and Guatemalan Tax Code, Arias & Muñoz Guatemala filed on behalf of the client a request for advanced ruling before the Ministry of Economy and a request for a binding opinion before the Tax Administration Office.

The binding opinion stated that the Ministry of Economy was the only public entity with power to rule in that respect and that they acknowledged the application of DR-CAFTA benefits to our client’s import operations from El Salvador to Guatemala.

This advance ruling was a strong precedent to file on behalf of the same client requesting advance ruling in Costa Rica. Arias & Muñoz Costa Rica obtained an advance ruling acknowledging the same benefits for the client last January.

Even though advanced rulings will only apply in our client’s specific operations, we have set an important precedent in the region since they are an indicator that DR-CAFTA preferential treatment will be applied to Central American companies’ trade operations within the region, regardless of their location or other applicable local tax reliefs.

TL: What are some of the main characteristics and fiscal benefits of the free trade zones that currently exist in Guatemala?

XT: The Free Trade Zone Law was modified on March 31st 2016 and most of the tax benefits were kept or enlarged, such as the income tax exemption for a 10-year period for free trade zone users. On another note, many industries were forbidden to engage in activities within the Free Trade Zones.

About 125 companies including pharmaceutical, cosmetics, plastics and footwear were affected by this new prohibition and faced challenges in order to comply with the new provisions and maintain their ongoing operations. Nevertheless, the remaining industries may file an application to be qualified as they will benefit from the following:
  1. Importation tax exemptions on raw materials, consumable goods, tools, semi-elaborated products, containers, packing materials, components and merchandises used in the production process or to provide services.
  2. Income tax exemption for a 10-year period on activities engaged as a free trade zone user.
  3. VAT exemption in connection with transfer of merchandise between free trade zone users.
  4. Stamp tax exemption on purchase of real estate property on activities engaged in as a free trade zone user.
  5. VAT exemption on the acquisition of consumable goods produced locally, which purpose is to be incorporated in the final product or service. 

TL: Given geographic proximity, what sort of impact, if any, will the Panama Papers have on Arias & Munoz’s business? Generally speaking, how do you see the Panama Papers changing the face of international taxation?

XT: Arias & Muñoz engages in a due diligence process and applies a “know your client” policy with all of its client. As a regional firm providing services to a broad scope of multinational companies, we have a serious commitment to apply anti-corruption rules and FCPA. For this reason, for example, the impact of the Panama papers in our course of operation was none.

I believe that the Panama Papers issue will be a clear example for all the law firms to implement KYC and anti-corruption policies and, as to international taxation, this incident comes to support the implementation of BEPS in jurisdictions that do not belong to the OECD. I believe that, as a result of all of these processes and the quest for transparency that is globally being engaged in, Central American jurisdictions will become attractive due to their low tax rates.